PDF Summary:Capital in the Twenty-First Century, by Thomas Piketty

What causes economic inequality? How can we address it? In Capital in the Twenty-First Century, award-winning French economist Thomas Piketty analyzes national incomes, income tax returns, estate tax returns, and other financial data across multiple countries and centuries. The result is a groundbreaking study of the history of economic inequality and its implications for 21st-century society. Piketty argues that capitalism, by its nature, generates economic inequality because the rate of return on capital “r” has nearly always exceeded the rate of overall economic growth, “g.” In other words, r>g. Piketty identifies r>g as a fundamental economic law—and the key divergent and destabilizing force in capitalism.

In this guide, we’ll present Piketty’s ideas while also introducing commentary and analysis from other economists and writers who take a different view of inequality to provide a more balanced perspective.

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For example, Facebook founder Mark Zuckerberg has a net worth of nearly $60 billion. Even if he earned “only” the average return of 5% per year, that would earn him an additional $300 million per year just on the returns from his existing wealth. Since that $300 million is, by itself, a staggering sum that most people would struggle to spend in a lifetime, Zuckerberg could consume only a relatively small portion of those returns (perhaps $37 million to purchase another sprawling estate in Palo Alto) and reinvest the remaining returns into his existing portfolio to earn even greater returns the next year.

Over time, the law of r>g will result in an enormous divergence of wealth. Piketty warns that, if left unchecked, a rising capital/growth ratio will enable capital to devour an ever-growing share of global income.

Elasticity of Substitution and the Uninvested “Returns” From Housing

Some writers have argued that Piketty overstates the case with regard to r>g. Former US Treasury Secretary Larry Summers writes that returns to capital diminish much more quickly than Piketty says and that far fewer returns to wealth are reinvested than Piketty claims. Summers argues that returns to capital hinge upon what economists call the elasticity of substitution, or the ease with which you can alternate between factors of production (primarily capital and labor).

In this case, Summers asks how much the returns to capital decline with each additional percentage point of capital. In other words, if capital increases by 1%, does the return on it relative to an equivalent increase in labor decline by more or less than 1%? Summers argues that if it declines by more than 1%, then the capital-to-income ratio will fall. Summers contends that the latter is usually the case, as the depreciation of capital tends to increase proportionally with the overall share of capital, which is also increasing.

Summers further argues that the largest component of capital in the US is housing. But, he writes, the most significant returns from this asset class come in the form of imputed income—the rent that owners pay themselves. Since this “return” is non-financial, it cannot be reinvested. This, Summers reasons, poses a significant problem for Piketty’s argument that there is a fundamental divergence in capitalism.

Part 4: The Return of Inherited Wealth

In the preceding sections, we’ve highlighted Piketty’s arguments about the coming demographic slowdown and the tendency of capital returns to be greater than overall growth (which Piketty notes mathematically as r>g) in a world with a rising capital-to-income ratio.

As growth slows down, Piketty warns that inherited wealth will come to account for a much greater share of overall wealth than that earned through work and savings. He writes that this is another indicator of rising inequality, as wealth earned in the past and handed down to rich heirs comes to far eclipse the wealth that people can earn in a lifetime.

(Shortform note: Some evidence suggests that the coming wave of inheritance has already begun. One paper relying on Federal Reserve and academic data estimates that about $36 trillion in wealth is set to transfer from its current owners to their heirs over the next 30 years. And that’s just accelerating the already-skyrocketing pace of bequests. In 2016, Americans collectively inherited a staggering $427 billion—an increase of 119% from a generation ago.)

The Baby Boomer Inheritance Windfall

Piketty projects that increased mortality rates—as the large and aging baby boomer cohort begins to die off—will contribute significantly to the growth of inherited wealth. The baby boomers, he writes, were the largest generation at the time of their birth—larger than any cohort that preceded them.

Because of their long lifespans relative to previous generations, they had more time to accumulate large stocks of capital—and, as long as the rate of return on capital is greater than the rate of economic growth (r>g), these stocks of wealth will continue to beget still greater wealth relative to economic growth as a whole. As the baby boomers begin to die off en masse, those growing capital stocks will be bequeathed to their heirs—representing a massive windfall of inherited wealth.

What this portends, Piketty warns, is a return to a historical era—like the Gilded Age in the United States, the Victorian Era in Britain, or the Belle Époque in France—in which getting a good education, working hard, saving, and investing wisely all count for far less than having the good fortune to be born to wealthy parents.

In Defense of Inheritance

Some economists dispute Piketty’s notion of a looming inheritance windfall. One paper found that from 1989 to 2007, the share of households reporting a wealth transfer through inheritance actually fell by 2.5 percentage points. Moreover, these researchers found, wealth transfers as a proportion of current net worth during this period dropped precipitously, from 29 to 19%. In contrast to Piketty, the authors of this paper found that inheritances and other wealth transfers tended to reduce wealth inequality by redistributing household wealth.

On a more fundamental level, other economists contend that there is nothing wrong or objectionable about inheritance even if it does result in significant inequality. In Capitalism and Freedom, Milton Friedman writes that it is impossible to determine how much anyone’s wealth is “earned” or “unearned,” however we choose to define the terms. But even if a system could somehow be devised that only redistributed “unearned” wealth (like from an inheritance) and left “earned” wealth alone, it would still be harmful to economic freedom.

This is because there is no moral difference between earned wealth and inherited wealth. Even if you inherit a vast fortune from your family, Friedman writes that it is still ultimately a product of human endeavor—at some point, someone did create that wealth. Moreover, Friedman argues that economic freedom demands that individuals have the ability to do as they please with their property, so long as it does not impose a cost on someone else. Thus, choosing to pass property along to one’s heirs is a perfectly legitimate act within a capitalist system.

An Unequal Society Is a Stagnant Society

Piketty argues that such a highly capital-intensive society is incompatible with a dynamic, meritocratic, and innovative economy where it pays to work hard, take risks, and acquire new skills. After all, if income from ownership matters more than income from labor, there’s little incentive to work. This introduces a potentially dangerous feedback loop of inequality: Demographic decline leads to lower rates of economic growth, which leads to a rising capital-to-income ratio, which increases inequality, which reduces incentives to work, which further reduces economic growth, and so on.

In such a society, working for a living is a sucker’s game. Instead, it’s better to be lucky enough to be born into wealth—or, at least to try and marry into wealth.

Inequality Is Dragging Down Growth

Some economic research supports Piketty’s argument that inequality acts as a drag on economic growth. According to one finding, income inequality, largely driven by the failure of workers’ pay to keep pace with the overall rise in productivity, reduces growth because it shifts spending power away from poorer households toward wealthier ones—and the latter are significantly more likely to save rather than spend. This has the effect of reducing the economy’s aggregate demand. Indeed, this paper estimates that in recent years, inequality has reduced GDP 2-4% below what it otherwise would have been.

To address the problem of inequality-fueled stagnant growth, the authors call for an aggressive, deficit-financed fiscal policy of direct cash transfers; more generous social spending; and, in the long term, greater collective bargaining power for workers through trade unions.

Part 5: The Role of Wage Inequality

So far, we’ve primarily explored concepts related to the dynamics of capital inequality—the capital-to-income ratio, the law of r>g, and the capital ownership distribution. But we haven’t yet touched on what Piketty identifies as a significant driver of overall inequality—wage inequality.

Piketty writes that economic inequality derives from wage (or income) inequality and capital (or wealth) inequality. As we’ve seen, capital inequality is inequality of income from capital due to unequal distribution of ownership of assets or unequal rates of return on different classes of assets.

Wage inequality, on the other hand, is inequality of income from labor. There are a multitude of factors at work in producing wage inequality—skill differences; hierarchical positions within organizations; educational attainment; as well as factors like age, race, and gender discrimination.

Human Capital and the Rise of Inequality

Other writers have emphasized the roles of skill and access to education—sometimes called “human capital”—in widening wage inequality. In Naked Economics, Charles Wheelan writes that human capital explains much of the rise in inequality.

Wheelan argues that the divergence in incomes corresponds with a divergence in the levels of human capital at either end of the economic spectrum and an economy that increasingly rewards skilled workers—that is, those with human capital. Almost every industry has shifted toward a need for computer skills, which has decreased the need for low-skilled workers but increased the need for high-skilled ones. For example, automatic teller machines have made many bank tellers redundant but at the same time have created jobs for computer programmers who design the machines.

However, because computer training and other such capital-building investment is often unaffordable for those at the very bottom of the social-economic ladder, they get shut out of the fastest-growing segments of the economy, leading to increased inequality between the upper and lower echelons of society.

Wages Are Driving the New Age of Inequality

Piketty writes that the history of economic inequality in the advanced economies of Western Europe and North America followed a distinct historical pattern—an era of high inequality in the period before World War I, followed by a significant compression of the wealth distribution in the decades after World War II, and a new age of rising inequality beginning in the 1980s and continuing to the present.

But he notes an important difference between the earlier period of massive inequality during the 18th, 19th, and early 20th centuries and the one we are living through today. Before World War I, a much larger share of the total income of the richest people came from ownership of capital assets—dividends, rents, interest on government bonds, and capital gains.

(Shortform note: The 19th century in particular was an era of staggering inequality. In the PBS documentary The Gilded Age, the filmmakers observe that in 1897, the richest 4,000 families in America controlled as much wealth as the other 11.6 million American families combined. But, as Piketty argues, we may be returning to a similar economic paradigm. In November 2017, the three richest individuals in America were as wealthy as the bottom half of the population.)

Since the 1980s, however, he observes that the top decile and even the top centile’s income primarily comes from highly compensated labor. He argues that skyrocketing salaries for high-ranking executives and managers (most notably in the finance sector) are driving today’s inequality. In this respect, today’s wealthy are different from their predecessors of the 18th and 19th centuries. They are less a class of rentiers than they are a class of highly compensated salary-earners.

But regardless of its source, Piketty warns that the rich are only getting richer: In the US, the top decile increased its share of national income by 15 points, from 35 to 50% from the 1970s to 2010.

(Shortform note: We can see direct evidence of Piketty’s argument by looking at the extraordinary divergence between average CEO pay and average worker pay that has taken place in the US since the mid-20th century. In 1965, CEOs earned, on average, 21 times more than the average worker. By 1989, that ratio had nearly tripled to 61:1. And by 2020, a CEO at one of the top 350 companies in the country could expect to earn more than 351 times the salary of a typical worker. In total, from 1978 to 2020, CEO pay grew by an exponential 1,322%—more than the growth in the S&P stock market growth during that time and the relatively paltry 18% wage growth of the typical worker over the same period.)

Wage Inequality Is a Choice

Piketty argues that this wage inequality is a political and social choice that our society has made. He acknowledges that wage inequality is partially a function of workers’ productivity—how much they contribute to the firm’s marginal output—and that this marginal productivity, in turn, is determined by workers’ education and skill levels.

But ultimately, writes Piketty, the mechanisms that allow for such a degree of overcompensation are the result of social, political, and legal decisions—specifically, to accept and even celebrate what he sees as unjustifiable income disparities.

These include political decisions about where to set the minimum wage (or whether to establish one at all); the level of legal protections afforded to labor unions; the degree of progressiveness of the tax system; the generosity of the welfare state; and how much we choose to invest in quality, universal education.

A Federal Jobs Guarantee to Address Inequality

Piketty writes that inequality is a result of the decision by our society and our governments to accept it. In The Deficit Myth, Stephanie Kelton similarly writes that the American political system has chosen to focus inordinately on purely fiscal deficits (how much the government spends vs. how much revenue it brings in), but is largely unconcerned with social and human deficits—the lack of jobs, the lack of education, the lack of healthcare, and the lack of equality of opportunity that are imposing significant suffering on people.

Kelton proposes using the federal government’s extraordinary fiscal power to create a society that is more equitable, sustainable, and prosperous through a federal job guarantee. She positions this as a crucial remaking of the economic order—having the federal government serve as an employer of last resort, guaranteeing the fundamental right to a job for anyone who wants one, and bringing important benefits to the economy and society as a whole.

She argues that such a guarantee would break the cycle of mass unemployment during recessions, improve the bargaining power of labor, and address society’s most pressing needs by creating much-needed jobs in nursing and eldercare, clean energy, and infrastructure repair.

Part 6: The Global Wealth Tax

Piketty argues that since the 1980s, wealth inequality has made a troubling comeback that demands a response. His proposed solution is a global wealth tax.

Such a tax would be progressive, with higher fortunes taxed at a higher marginal rate than smaller fortunes. The tax would be relatively low (perhaps 1-2% of net worth per year) and would be assessed annually on the combined net worth of market assets of all asset classes.

Piketty argues that the purpose of the tax would not be to raise revenue. Instead, its purpose would be to stop the unchecked accumulation of wealth by the global hyper-wealthy, end the financial opacity that allows so much of the world’s wealth to exist in the shadows, and bring some much-needed redistribution of economic resources.

The Mixed Record of Wealth Taxes

Piketty’s proposal for a global wealth tax has been a hot topic in economics circles since Capital in the Twenty-First Century’s publication in 2013, generating both praise and criticism.

In the US, progressive politicians like Elizabeth Warren have made wealth taxes a central part of their political programs, claiming that a national version of Piketty’s tax could raise nearly $4 trillion in revenue that could be reinvested and redistributed to the poor and middle class.

But others have criticized the idea of wealth taxes and pointed to their failure in the countries where they have been implemented. Notably, Piketty’s native France had a wealth tax from 1986 to 2017, but it proved self-defeating—more than 12,000 millionaires left France in 2016 alone, creating a net loss of 60,000 high-net-worth individuals between 2000 and 2016. This exodus cost France tax revenue it would have otherwise collected from the wealth tax itself, in addition to income tax and value-added tax (VAT). Ultimately, French President Emmanuel Macron ended the wealth tax in 2017. The experience of other nations tells a similar story. In 1990, 12 European countries had some form of wealth tax: By 2019, only three did.

However, it’s worth noting that Piketty’s proposal would, in theory, eliminate the possibility of the ultra-wealthy fleeing to another jurisdiction to escape the wealth tax. Because his tax would operate on a global scale, there would be no safe havens for the world’s economic elite to shield their assets.

Bringing Transparency to the Global Financial System

Piketty further argues that even the assessment of such a tax would bring great clarity to the global financial system, as it would show precisely who owns what assets, how unequally wealth is distributed, and what policies might be best suited to address it.

The assessment of the global wealth tax would require significant (and unprecedented) sharing of banking data between countries and cooperation between tax authorities. But this degree of transparency would enable countries to accurately calculate the net worth of each of their citizens—regardless of where those citizens choose to hold their assets—and significantly cut down on tax evasion.

Cracking Down on Tax Havens

One of the reasons it’s so difficult to enforce tax compliance on a global level and crack down on evasion is the existence of offshore financial centers, commonly known as tax havens—countries that offer minimal tax rates on assets and incomes. These tax havens attract enormous amounts of foreign capital from corporations and wealthy individuals who wish to avoid higher taxes in their home countries. By one estimate, $36 trillion worth of assets were stored in these untaxed corners of the world in 2021.

Although Piketty’s vision for a global wealth tax remains a political pipe dream today, some of the world’s largest economies are considering plans for a global minimum corporate tax. In 2021, leaders of the G20 countries (representing approximately 80% of global GDP) formally endorsed their support for a 15% global minimum corporate rate for multinational corporations, to begin in 2023. This new framework is part of a proposed overhaul of the global tax system and has the official backing of nearly 140 nations. If implemented, these rules would make it more difficult for major corporations with business activities in multiple countries to skirt their tax obligations by setting up nominal headquarters offices in low-tax jurisdictions or offshoring profits.

The Necessity of Progressive Taxation

Piketty argues that progressivity—in which the tax burden falls most heavily on society’s wealthiest—is necessary for the tax system to function fairly. He writes that if the system were not set up this way and instead taxed the wealthy at lower rates and the poor at higher rates, middle and working-class people (who vastly outnumber the rich) would rightly begin to question why they should pay a higher share than the rich.

He warns that this could lead to the mass rejection of the very idea of a social state and a democratic society that has certain basic obligations to all its citizens.

Is a Market Society an Unequal Society?

In What Money Can’t Buy, philosopher Michael Sandel explores this theme of wealth inequality and the threat to a democratic society. Sandel writes that a market society is inherently a divided society—one in which more and more wealth is concentrated in the hands of fewer and fewer people, with these inequities only exacerbated by a regressive tax system. Unlike Piketty, Sandel is primarily concerned about the social consequences of inequality. Specifically, he warns that the financial gap between the affluent and the poor leads to social divisions, in which these groups share fewer and fewer common spaces and experiences.

Sandel argues that these developments are very dangerous for a democratic society, in which all citizens are supposed to be equal and share a common stake in the community’s welfare. When society’s wealthiest members lead such vastly different lives from everyone else (and have so much more power than everyone else) those bonds of commonality get weaker.

For example, the richest citizens might feel that they have little stake in the welfare of their fellow citizens because they have enough money to never have to worry about underperforming schools, crumbling infrastructure, or an antiquated healthcare system. The poorest citizens, meanwhile, might feel alienated from the common civic project if they come to feel that the political and economic system is rigged against them.

Piketty notes that progressivity encompasses more than just the taxation rates applied to income. Progressivity also comes from the kind of income being taxed. In particular, taxes on wealth and inherited wealth (both of which are forms of capital income) especially could be powerful tools for scaling back the wealth inequality that has defined most developed countries for the past 40 years.

The Case Against Progressive Taxation

Some economists have taken the opposite view of Piketty—namely, that progressive taxation harms lower-income families and individuals and creates perverse distortions of the tax system. In Capitalism and Freedom, Milton Friedman writes that progressive taxation increases pre-tax income inequality. He argues that if high earners know that their top marginal tax rate is going to be high, lucrative jobs become less attractive than they would otherwise be. The only way to compensate for this is to make these kinds of jobs even more well-paid—thereby increasing pre-tax inequality.

He also writes that progressive tax codes are nearly always more complex than alternative systems because they contain all sorts of loopholes and deductions that tax certain kinds of income (like capital gains) at different rates than other kinds of income (like standard wages and tips). This creates a strong incentive for wealthy people to devote inordinate resources to devising complex and wasteful tax-avoidance schemes.

Friedman further argues that despite the desires of economists like Piketty to use the tax system to more equitably distribute economic resources, progressive taxation systems designed to compel redistribution are inherently unjust. One of the cornerstones of a society based upon voluntary exchange is the right to keep what you earn because what you earn in the market is a product of the productive capacity of your own labor and capital.

The fairest and most efficient way to allocate resources in a system of voluntary exchange is through payment according to product. Your compensation is a direct result of the value you create in the economy through your labor (the work you perform for which you are paid in wages and tips) and your capital (the productive assets you own, like land or machinery).

Friedman argues that there is no moral justification for a majority to compel a minority to hand over its property—whether it’s a gang of armed robbers telling you to hand over the cash in your wallet or a majority of voters passing legislation to legally confiscate wealth from the so-called “1%.”